The Sharing Economy
In recent years, it has become quite commonplace to get a ride home in a perfect stranger’s car with only a few button presses of a smartphone. Similarly, many people think nothing of booking a weekend getaway to stay in someone else’s home; all booked and paid for online. In fact, Statistics Canada reports that 1 in 10 Canadians are now using peer-to-peer ride services, or private accommodation services, such as Uber and Airbnb. A current estimate by PWC, a consultancy, suggests that global spending on these kinds of arrangements will reach $335 billion by 2025.
A notable aspect of this type of economic activity is that we are sharing privately owned assets. In most cases, Uber drivers are giving us a ride in their own cars and Airbnb hosts are putting us up in their own houses. While much of this is not new, modern technology has propelled vast growth in the so-called “sharing economy”. The internet, smartphones and apps have made it easier than ever for buyers and sellers to connect. Further, these marketplaces can create and promote trust and good behaviour through a transparent shared rating system. Inhospitable landlords are soon exposed, while destructive tenants will ultimately find it hard to get a place to stay.
These innovations have transformed many traditional markets; something CRA has become acutely aware of. In CRA’s “Underground Economy Strategy 2018 – 2021”, they cite new business models resulting from the expansion of the sharing economy and transacting in the digital age as specific areas that are being targeted for enforcement activity.
For taxpayers, this new world has created a whole host of tax issues. For many, compliance has become more complicated, and there are a number of possible pitfalls for those wanting to take advantage of the business opportunities that present themselves. In fact, some participating in these activities may not even realize that they must take on the responsibilities of a business owner.
In this edition of the Canadian Tax Planner, we shall discuss general tax compliance in the sharing economy. Following which, we will examine specific tax issues as they relate to two of the more prominent sectors of this new commercial landscape; accommodation sharing and ride sharing.
Specifically, we will discuss:
- PART 1: Tax Compliance in the Sharing Economy
- PART 2: Accommodation Sharing
- PART 3: Ride Sharing
PART 1: Tax Compliance in the Sharing Economy
For the purposes of our discussion, we can view the sharing economy as interactions in which individuals or less formal businesses share personal property or services with others for payment. CRA adds that “sharing economy arrangements are generally booked using online platforms through a third party, using a website or a software application”.
CRA identifies the following five main sectors in which we are seeing the sharing economy proliferate:
- Accommodation sharing – renting out homes, rooms and cottages
- Transportation – ride sharing, rentals of bikes or boats
- Space rentals – desks, workspaces, laboratories
- Making and selling goods – household goods, jewelry and beauty products
- Providing services – dog walking, esthetics services and professional expertise
This list is far from exhaustive, but it highlights some of the main areas where we are seeing an evolution in traditional marketplaces. There are many examples of online and/ or app-based services that epitomize these sectors, including:
- Uber – the world’s largest ride sharing platform with over 110 million users; individuals can book a ride online or by using a smartphone app (some metropolitan areas are not yet serviced due to regulatory hurdles)
- Airbnb – online marketplace for arranging or offering lodging, primarily homestays, or tourism experiences
- WeWork – a commercial real estate company that provides shared workspaces and workplace services for start-ups and entrepreneurs
- SkipTheDishes – an online marketplace that connects customers to restaurants and food couriers
- Freelancer – the world’s largest freelancing and crowdsourcing marketplace, connecting employers and freelancers across a wide variety of industries and areas of professional expertise
- Etsy – an e-commerce website that focuses on handmade, craft and vintage items; such as clothing, jewelry, home décor, art and furniture
One of the key issues with the sharing economy is that it is often quite informal. For example, an individual looking to earn a little spending money on the side might put in a few hours a week driving passengers from A to B or delivering takeaway dinners in their local area. Others might have a woodworking hobby and decide to sell some of the furniture and artwork that they have been making on the weekends.
Given the informal nature of these activities, there is more of a tendency to overlook the fact that income earned is reportable for tax purposes. Irrespective of the sale type, amount, or method, earnings from business activity in the sharing economy must be reported. Further, even when an activity is ostensibly a hobby, if it is conducted with a view to making a profit, it is considered to be a business. While there are no T-slips issued for making homemade cribbage boards, any profits earned from selling them on Etsy, or any other platform for that matter, must be reported.
Another common issue for taxpayers in the sharing economy is determining which expenses are deductible and which are not. To be deductible, expenses must be incurred to earn income, not be personal or living expenses, and not be capital in nature. Further, expenses must be reasonable in the context of the business. Some expenses are specifically prohibited, while others may be limited.
As the name “sharing economy” implies, much of the income derived from these activities results from sharing personal property. As such, individuals participating in the sharing economy quite often need to establish a rational basis for determining the personal and business components of their expenditures.
For example, someone renting out their basement would need to be able to work out how much of their heating costs to deduct. Generally, the percentage of the home’s square footage that is being rented out would serve as a reasonable basis for allocating expenses. Likewise, Uber drivers need to allocate certain expenses, such as gas and maintenance. In most cases, the proportion of business vs. personal mileage would suffice as a rational basis for allocating these types of costs.
Collecting and remitting GST/ HST
Again, due to the somewhat informal nature of much of the work that is performed in the sharing economy, individuals have a greater tendency to overlook the fact that they may need to collect and remit GST/ HST.
Taxpayers that earn more than $30,000 of gross revenue, including earnings of those associated, in either a single quarter or cumulatively over four consecutive quarters, must register for and start collecting and remitting GST/ HST. Those earning amounts below this are eligible for the small-supplier exemption. Nonetheless, taxpayers that are already registered for GST/ HST are required to collect and remit, even if their gross revenues do not exceed $30,000. Note that there are some specific rules for taxpayers working in the ride sharing sector, which we discuss in PART 3.
CRA has identified the sharing economy as an area of particular focus. This is perhaps unsurprising given the potential scope for underreporting income and/ or inappropriately deducting business expenses. As a result, CRA has devoted considerable resources and initiated projects to reduce non-compliance, which include:
- Educational campaigns – CRA has released a number of Tax Tips that set out the basic tax compliance requirements for individuals earning income in this sector. In addition, CRA has a number of webinars to help educate small business owners in areas like GST/ HST filing and deducting expenses. Of course, this is helpful only if the participant in the sharing economy realizes they are carrying on a business.
- Partnerships with other government departments and industry – CRA has stepped up information sharing initiatives between various levels of government and with industry to help detect unreported income. For example, CRA has been using provincial land registry information to identify non-compliance related to real estate transactions and has partnered with Statistics Canada to help target its enforcement activities across the wider economy. As for industry partnership, Airbnb now collects local lodging tax and PST on behalf of landlords for short-term rentals in a number of jurisdictions.
- Using legal authority to obtain third-party information – CRA can request information from organizations related to a taxpayer’s obligations and may even compel organizations to turn over third-party data by getting a court order. This approach is usually used to obtain data that CRA then cross-checks against an individual’s or company’s tax filings to look for discrepancies. In recent years, CRA has sourced data from PayPal and Square Canada to examine payments processed through these services. Revenue Quebec has also obtained information from Uber relating to whether drivers were appropriately collecting and remitting sales tax in Quebec. CRA has stated on a number of occasions that it will expand and increase its use of third-party information.
Tip! In short, CRA has various mechanisms by which it can identify non-compliance, and the sharing economy is of particular interest. With this in mind, individuals working in this sector should pay particular attention to reporting all of their income and having a defensible rational basis for deducting the expenses incurred to earn that income.
Tip! Individuals that have failed to properly comply with their income tax, or GST/ HST obligations, might consider applying for CRA’s Voluntary Disclosure Program. Under the program, some or all penalties and/or interest may be waived, although the tax must still be paid.
PART 2: Accommodation Sharing
Accommodation sharing is perhaps the most traditional of the sharing economy business models, especially when it comes to renting out privately owned cottages. Nevertheless, the internet has driven the sector forward significantly by providing a marketplace that is so readily accessible and more transparent to both guests and hosts.
The sector has many online platforms. Some of the larger ones include Airbnb, VRBO, Homestay, HomeAway.ca, Booking.com Apartments, Trip Advisor Rentals and Flipkey. Some of these platforms were originally associated with hotel stays, but have since expanded into the private rental sector, a mainstay of the sharing economy.
For homeowners it is now easier than ever to make some extra money by renting out a home or cottage on a short-term basis. However, there are various important tax issues to consider before deciding to list one’s property.
Rental income or business income?
From a tax perspective, it is important to determine whether the income earned through accommodation sharing is business income or rental income. For individuals, the tax rate is the same for both income sources, however business income is subject to Canada Pension Plan premiums. Further, there are various differences in the way in which the tax return must be completed.
To determine whether the income is business or rental, taxpayers should consider whether they are providing more than the basic services that would be associated with a rental space (such as, utilities, parking and laundry facilities). Ancillary services, such as meal preparation and cleaning might indicate that there is a business. In most cases, home-sharing is considered a rental activity as extra services are normally not provided.
Changes in use
When there is a change in use of a property a taxpayer owns, there may be a deemed disposition, which in some cases has the potential to trigger a capital gain and along with it a hefty capital gains tax bill. With a deemed disposition, the taxpayer is considered to have sold the property at fair market value and to have immediately reacquired it for the same amount. The capital gain must be reported in the year the change in use occurs.
Examples of when a change in use occurs include:
- The taxpayer changes all or part of their principal residence to a rental or business operation
- The taxpayer changes their rental or business operation to a principal residence
These scenarios are directly applicable to the accommodation sharing business. Anyone wishing to earn rental income from a property, or who ceases doing so and just wants to move back into their home should take note of the change in use rules. Thankfully, there are some exceptions to these rules that may either preclude the need to pay capital gains tax or at least defer when it must be paid.
Principal residence exemption
For any of the years that a property is designated as a taxpayer’s principal residence, the taxpayer is exempt from tax on the capital gain that is realized when the property sold (known as the principal residence exemption). As such, the taxpayer must report a capital gain on all or part of their property for the years in which the property was not designated as their principal residence (notwithstanding the “one plus” rule).
The “one plus” rule, in effect, allows taxpayers to claim one extra year of the principal residence exemption over and above the years that the property was actually designated as such. Since a taxpayer can only designate one property as a principal residence in any given tax year, this rule means that an individual that sells their principal residence and then buys a new one in the same year need not be denied the principal residence exemption on one of those two properties for that tax year (i.e. a continuity can be maintained).
Exceptions to the change in use rules
In certain situations, the change in use rules do not apply. Some of the more common scenarios are discussed below.
Changing part of a principal residence to a rental or business property
A taxpayer is not considered to have triggered a change in use of their principal residence, where all of the following applies:
- the rental or business use of the property is relatively small in relation to its use as a principal residence;
- no structural changes were made to the property to make it more suitable for rental or business purposes; and
- the taxpayer does not deduct any CCA on the part of the property that is being used for rental or business purposes.
Where there is no change of use, there is no deemed disposition and the property remains a principal residence in its entirety for tax purposes. An example of this might be where a homeowner rents out their basement suite on Airbnb, makes no structural changes to their home and claims no CCA on the property. Actually, this could also be the case where an individual rents out their whole home for a short period.
Changing all of a personal use property to a rental or business property
Taxpayers have the option of making an election (Subsection 45(2)), which allows them to avoid the deemed disposition and continue to treat the property as if it were still held entirely for personal use. Where the election is made, the net rental or business income must still be reported, and CCA may not be claimed on the property. If desired, the election can later be rescinded, resulting in a deemed disposition in that year.
This election allows the property to be designated as the taxpayer’s principal residence for up to 4 years even if the taxpayer did not ordinarily inhabit it at any time during those years. The period may be extended even longer if the taxpayer or their spouse were required to relocate for work (provided that their new temporary residence is more than 40km away from their original home).
Tip! The above 2 elections are currently applicable only to a complete change in use of a property, however, the 2019 Federal Budget proposed to extend these to partial changes of use.
Changing a rental or business property to a principal residence
A taxpayer that rents out a property and then subsequently decides to move into it and designate it as their principal residence will ordinarily trigger a deemed disposition. This means that they will have to report any capital gains and contend with the resulting tax bill in short order. However, the taxpayer has the option of making an election (Subsection 45(3)) to postpone the reporting of the disposition until such time as they sell the property. This election is not available to anyone that has claimed CCA on their property in any tax year after 1984.
Tip! Taxpayers should exercise caution before deciding whether or not to claim CCA on a property. None of the aforementioned exceptions apply where it has been claimed. While it is hard to predict what will ultimately happen, where a taxpayer considers it likely that they will either continue to treat all or part of a property as their principal residence (or will eventually do so), there is good reason to carefully evaluate the tax consequences before claiming any CCA.
Registering for GST/ HST
Taxpayers are required to collect and remit GST/ HST on short-term accommodation rentals. Short term accommodation rentals are those for which the period of occupancy is less than one month. Whereas, rentals for periods longer than one month are exempt from GST/ HST.
Much of the growth in the accommodation sharing market has been in the short-term rentals category. As such, the requirement to register for, collect and remit GST/ HST is new to many taxpayers, especially for those who find themselves exceeding the $30,000 threshold for the first time. There are detailed instructions on how to register for a GST/ HST account on the CRA website, as well as how to file returns and remit amounts collected.
Tip! At present, Airbnb, and other similar platforms, do not normally collect and remit GST/ HST on behalf of hosts using their platform. So, it is up to the property owners to ensure that they collect and remit the appropriate amounts (while, Airbnb does collect/ remit other amounts in certain jurisdictions, it does not do so for GST/ HST). Other taxes at the municipal and/or provincial level may also apply.
Input tax credits
The upside of collecting and remitting GST/ HST, is that the taxpayer can often claim input tax credits (ITCs) on the GST/ HST paid in conjunction with expenses incurred to operate the business. The taxpayer can then recover the ITCs, typically by netting them off against any amounts owing, when filing their GST/ HST return.
Tip! In some instances, taxpayers may voluntarily register for GST/ HST accounts, even if they are below the $30,000 gross revenue threshold in order to benefit from the ability to claim ITCs on operating expenses. Whether or not this is beneficial will depend on the net amount of tax that would likely be claimed, after remitting any GST/ HST owing.
GST/ HST issues – real estate sales and changes in use
From a GST/ HST perspective, there can be very significant consequences when a property changes from personal use (not subject to GST/ HST) to a taxable use (subject to GST/ HST). The impact can vary greatly depending on a number of factors such as the type of property, how the usage changes, who owns the property (individual or corporation), and whether the owner is registered for GST/ HST.
For example, consider an individual who buys a house for their own personal use and then at a future date decides to rent the property on a short term basis. When they rent the property out, the house is converted from personal residential use to business short-term taxable use. The individual would then be able to claim an input tax credit (ITC) on the basic tax content of the capital property. If there was no GST/ HST paid on the property, there would be no ITC. The individual would be eligible to claim ITCs on the costs associated with operating the property to the extent that it is used to make taxable supplies.
Should the individual cease to use the property for taxable activities (short-term rentals), there would also be more GST/ HST implications:
- if the property is sold while it is being used for short-term rentals, the sale of the property would be subject to GST/ HST;
- if the individual removes the property from the short-term rental market and takes it back for personal use, the ITC recovered on the basic tax content must be repaid; and
- if the individual converts the property from short-term rental to exempt long-term rental, the individual is able to keep the ITC claimed on the basic tax content, but the individual is required to self-assess GST/ HST on the FMV of the property. Depending on the value of the property, the landlord may be eligible for the rental property rebate.
Tip! Specialized professional advice should be sought in this area as it is very complex and the tax results can vary significantly. Tip! Taxpayers looking to rent out their properties should carefully review the provincial and municipal taxes assessed on short-term rentals in their local area. While some of these taxes are collected and remitted on behalf of the taxpayer, others are not.
Other occupancy taxes
In many cases there are other occupancy taxes to collect and remit in the accommodation sharing world. These vary considerably by jurisdiction and may or may not be collected and remitted by Airbnb and other platforms.
In BC, Airbnb collects and remits PST and municipal and regional district taxes on behalf of its partner hosts. In Quebec, Airbnb collects and remits a lodging tax, while various cities in Ontario have their own municipal accommodation taxes that are also collected and remitted by the platform.
Tip! Taxpayers looking to rent out their properties should carefully review the provincial and municipal taxes assessed on short-term rentals in their local area. While some of these taxes are collected and remitted on behalf of the taxpayer, others are not.
PART 3: Ride Sharing
Ride sharing is another key sector in the expanding sharing economy. Using a web browser or smartphone, customers can book rides in privately owned vehicles via a third-party intermediary. In North America, most of the market is occupied by two platforms, Uber and Lyft. These services are gaining in popularity and have been a source of major disruption to traditional taxi services.
Metropolitan areas across Canada have different approaches to the ride sharing phenomenon. Some consider it to be a welcome innovation in a modern world, while others worry that it is insufficiently regulated and represents an unfair encroachment on taxi operators. As such, ride sharing service are only available in some cities.
Those working in the ride sharing business, as with other sectors in the sharing economy, must report all of the income that they earn through providing these services and establish a reasonable and supportable basis for deducting business expenses. As discussed, CRA is actively targeting enforcement activities towards the new business models of the sharing economy. With this in mind, drivers should be especially careful to accurately report all of their income.
GST/ HST issues
Unlike most commercial activities, including accommodation sharing, there is no small-supplier exemption for individuals working in the ride sharing business. After July 1, 2017, drivers are required to collect and remit GST/ HST on all of their fares, regardless of the amount of sales.
Both Uber and Lyft already include GST/ HST in every fare their drivers charge, but the drivers themselves are responsible for registering, filing, collecting and remitting GST/ HST (with the exception of Quebec, where Uber collects and remits QST on behalf of its drivers).
Each week Uber and Lyft drivers receive a statement detailing the GST/ HST that was collected, representing the amount that they need to remit. As with other businesses, once registered for GST/ HST, taxpayers in the ride sharing business are usually able to claim ITCs on their operating expenses, such as gas, maintenance and car washes (this also includes ITCs on any fees paid to the ride sharing service for using their platform).
Tip! It is important to keep good records of the ITCs claimed in the event of an audit. Further, drivers need to establish a rational basis for allocating expenses between business and personal use, to determine the portion that may be claimed as an ITC. CRA typically expects detailed records of business and personal mileage (such as a log tracking all kms driven) for mixed use vehicles to support both expense deductions as well as the ITCs that are recovered.
WARNING: This information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a newsletter such as this, a further review should be done by a qualified professional. No individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortuous, or any other form of liability for its contents or for any consequences arising from its use. Photocopying, replication or any other reproduction of the information contained within the newsletter, for any reason, other than a single page for reference only is strictly prohibited. Copyrighted © Video Tax News Inc. 2019. Date of Issue – November 2019. This periodical is published six times per year in January, March, May, July, September and November.
While the sharing economy is breathing new life into various traditional sectors and making it easier than ever for buyers and sellers to meet and transact, these innovations come with a variety of tax implications. Taxpayers should take care to understand their options and their obligations; especially given the increased scrutiny these new business models are receiving from CRA.
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